Tuesday, October 9, 2018

What is Economies of Scope?

Economies of scope is an economic concept that the unit cost to produce a product will decline as the variety of products increases. That is, the more different-but-similar goods you produce, the lower the total cost to produce each one.

For example, let’s say that you’re a shoe manufacturer. You produce men’s and women’s sneakers. Adding a children’s line of sneakers would increase economies of scope because you can use the same production equipment, supplies, storage, and distribution channels to make a new line of products. That will further reduce the cost of production on all your shoes.

The cost to produce all three of your different lines is lower than if three different companies each produced a line of men’s shoes, a line of women’s shoes, and a children’s line. Because you can extend the use of your resources to make more products to be sold to your same target market, you can continue to drive costs down.

Economies of Scale

You’ve probably heard of economies of scale, which is a similar economic concept – but not exactly. Economies of scale are gained simply by producing more products – through more volume. So if you were a necklace manufacturer, you could reduce the cost per piece by producing more necklaces. As production increases, the average cost per unit declines.

n contrast, with economies of scope, you need to produce more different types of products using the same resources. So instead of producing more necklaces, you would also produce bracelets and rings and earrings and charms, for example. You would add new types of products that could be produced with the same equipment and materials in order to reduce your average costs.

Generalist or Specialist

The challenge in pursuing economies of scope is the possibility of diluting what your business was originally known for. So, let’s say you built a business based on trendy dog clothes. You supplied handmade dog sweaters that were long-lasting and warm and clever. It’s what you were known for.

To continue to build your business, you could focus on selling more of what you already sell. That’s economies of scale. It also preserves your brand identity as a dog fashion guru.

However, another strategy is to grow your business by expanding the markets you serve, by adding products for animals other than dogs, like cats, and pigs, and goats. You can still sell pet sweaters, just to a broader audience. You’d no longer be a dog fashion guru, but rather a pet sweater guru.

There’s no right or wrong answer here, it’s just a matter of determining what makes the most sense for your business. Do you go deep or do you go broad product-wise in order to grow?